Posts Tagged ‘overconfidence’

Richard Thaler and Daniel Kahneman are interviewed for an NPR story about lessons from behavioral economics. Long before he was a psychologist at Princeton, Kahneman was a psychologist in the Israeli army where one of his major tasks was evaluating soldiers and deciding which ones were likely to make good officers. To separate the good from the bad, Kahneman had groups of 8 soldiers figure out how to lift a giant telephone pole over a wall. The idea was that leaders, followers, and quitters would emerge. The telephone poll test turned out to be useless, however. There was no relationship between Kahneman’s evaluations and the evaluations at officer school based on six months of performance. Even after learning about the non-relationship, Kahneman initially didn’t believe it.

“The next day after getting those statistics, we put them there in front of the wall, gave them a telephone pole, and we were just as convinced as ever that we knew what kind of officer they were going to be.”

Investors with an “overconfidence” bias often trade too much and manage their portfolio on a stock-by-stock basis—while assuming they can beat the market, which the University of Chicago’s Mr. Thaler says probably won’t happen.

Mr. Thaler recommends a little test for the presence of an overconfidence bias. “Write down 10 traits [such as ‘investment skill’ or ‘ability to make good stock picks’], then ask yourself how you rate compared to your co-workers. If you rate yourself above average on all of them, plead guilty,” he says.

CEOs develop overconfidence with each merger and acquisition decision, playing up their own role in the successes, thus leading to more deals, many of them bad, according to new University of Iowa research. CEOs are so overconfident they shift their stock portfolios prior to the deals.

Overconfident CFOs “tend to use lower discount rates when valuing cash flows and assign higher values to projects,” according to University of Chicago research. The companies they work for invest more, use more debt, and are less likely to pay shareholder dividends. Seven thousand CFOs were asked, in a survey, to make predictions about the S&P 500 from 1-10 years. Just 38 percent got it right – and they were usually the least confident CFOs.

The U.S. government keeps trying to fix the airport mess. In an effort to speed up congested terminals, the Transportation Safety Administration recently unveiled its plan for 21 airports to split the standard single security line into three “self-select” lines that people can choose between. The lines, modeled after ski slope categories, are for “families and special assistance” (marked in green), the “casual traveler” (in Aspen ice blue), and the “expert traveler” (black like the diamond). According to theNew York Times, TSA officials have now learned what Thaler’s business school students know all too well: As humans, most air travelers are overconfident.

The Boston Globe writes about optimism research, and includes the following cautionary nugget about the virtues of moderate optimism.

Economists at Duke found that compared to pessimists, optimists work more hours per week, save more money, are more likely to own stock, and are more likely to say that they’re never going to retire…”The moderate optimists are prudent people,” said David Robinson, who conducted the Duke study. “They pay their credit cards on time. They tell you that they save because saving is a good thing to do. . . . Extreme optimists are just the opposite. They have short planning horizons, they don’t pay their credit cards off on time. As you get extremely optimistic, the good behaviors drop off.”

And this nugget about when optimism is beneficial and harmful.

The importance of positivity can vary by profession. University of Pennsylvania psychologist Martin Seligman, a leading researcher on optimism, has found that pessimistic law students are the most successful. Optimistic sales agents, on the other hand, significantly outsell pessimistic ones.

Asked to predict their grade on the first day of Thaler’s decision making class, about 95 percent of Chicago business school students say they will end up above the median grade.

Asked to assess their own children, 90 percent of parents rated their offspring as “above average” in the areas of intelligence, humor, sensitivity, and caring. This according to a study just published in the Journal of Applied Social Psychology.

Richard Thaler gets the second half of this Yale University Press podcast. The recording lasts about 29 minutes. Thaler’s interview starts at approximately minute 14.

Cass Sunstein was in Washington yesterday where he spoke on a panel about libertarian paternalism at the Cato Institute. Click here to watch (via Real Player) or listen to an mp3 of the one hour and thirty minute event. Sunstein kicks off the discussion with a 20-minute lecture. Terrence Chorvat of George Mason University Law School and Will Wilkinson of Cato Institute then respond. The panel concludes with about 30 minutes of questions.

Sunstein brings up overconfidence studies that find 90 percent of drivers and professors think they are better than the average driver and professor – which we know is mathematically impossible! The only people who don’t exhibit such overconfidence? The clinically depressed.

Disclaimer

The Nudge blog is associated with the book Nudge: Improving Decisions about Health, Wealth, and Happiness, by Richard Thaler and Cass Sunstein. Sunstein is currently the Administrator of the White House Office of Information and Regulatory Affairs and has no affiliation with the Nudge blog.